Posted on: April 08, 2014

Author: Staff

It's easy to get caught up in interest rates and move-in dates, but if you want to make a smart home-buying decision, you've got to know some important mortgage details.

Here's a run down of six important mortgage terms and tips for choosing the option that's right for you:

Fixed and variable.

With a fixed rate mortgage, your interest rate and payments won't change for the term of your contract. Because the rate is guaranteed, it's usually higher than the variable mortgage rate over the same term.

With a variable rate mortgage, the interest rate changes according to your bank's mortgage prime rate. When the interest rate drops, more of your payment goes towards the principal (your original borrowed amount). When the interest rate increases, more of your payment goes towards interest. If your payments no longer cover the required interest, your payment amount will go up.

So what's right for you?

If rates are expected to go up in the near future, you may want to go fixed and lock in at the current low rates. This is also a good choice if you have a strict budget. On the other hand, if you think it'll be a couple of years before rates rise (as some experts are predicting) and you can handle some potential fluctuation in your payments, a variable rate can save you a lot of money—in the short and possibly long term.

Term.

Your mortgage term is the length of time your mortgage details are guaranteed. Shorter terms generally offer lower rates, but you'll have to renew earlier (when rates might be higher).

So what's right for you?

The most common term is five years, but, depending on your mortgage, you can go as short as six months or as long as 10 years. Think about how long you'll stay in your home and what rates are expected to do in the next few years.

With a closed mortgage, it's difficult (and expensive) to pay off your mortgage early or switch lenders before your term is up—but you will receive a better rate for your commitment. With an open mortgage, your rate is usually higher but you can make extra payments, pay off your mortgage entirely, or switch lenders at any time.

So what's right for you?

If you're confident you can commit to your mortgage contract for the full term, a closed mortgage is the way to go. Not so sure? Open gives you more flexibility.

Amortization.

Amortization is how long it will take you to pay back your full mortgage (the original borrowed amount plus interest). In Canada, the maximum amortization period is 25 years.

The longer your amortization period, the lower your mortgage payments will be—but the more you'll end up paying in interest.

For example, using a $200,000 mortgage at 5% (per annum):

Amortization (assuming same interest rate over entire period)

Monthly payment

Total interest costs (over the life of your mortgage)

Interest saved

15 years

$1,576.65

$83,724.57

$65,238.42

20 years

$1,314.25

$115,420.02

$33,542.97

25 years

$1,163.21

$148,962.99

N/A

So what's right for you?

Reducing your amortization allows you to minimize your interest payments and pay down the principal faster—which is always a good thing. Figure out your budget and go with the shortest amortization period that you can afford.

Payment schedule.

You can make your mortgage payments monthly, semi-monthly (twice a month), bi-weekly (every two weeks), or weekly. Semi-monthly and bi-weekly may seem like the same thing, but in reality, bi-weekly payments can save you thousands in interest and help you pay off your mortgage years earlier. This is because, with semi-monthly payments, you'll make 24 payments a year (two per month); with bi-weekly, you make 26 payments a year (half of the year's 52 weeks). That's two extra payments every year—which can add up to thousands in savings.

Using a $200,000 mortgage at 5% (per annum):

Payment frequency

Payment

Actual amortization (years)

Total interest costs (over the life of the mortgage)

Interest saved

Monthly

$1,163.21

25

$148,962.99

N/A

Accelerated bi-weekly

$581.60

22

$124,094.94

$24,868.05

So what's right for you?

It's probably most convenient to align your mortgage payments with your paycheques—but if you get paid semi-monthly (on the 15th and 30th of every month, for example) and your budget can accommodate the extra two payments of the bi-weekly option, you should go for it. The savings can be huge.

Portability, blending and extending, skip payments, and pre-payments.

These are a few options that may be available to you, depending on your mortgage.

Portability: If you decide to move before the end of your term, you may have the option to transfer your existing rate, loan balance, and maturity date to your new home without paying any penalties.

Blending and extending: Another option if you're planning on buying a new home or renewing your mortgage early, blending and extending allows you to blend your current rate with a new rate, while adding your new mortgage term on the end of your current term.

Skip payments: Some lenders allow you to skip one or two months of mortgage payments every year, a good option if your income fluctuates.

Pre-payments: You may have the option of increasing your payments by a certain per cent each year or prepaying up to a certain per cent of your loan each year, making a big dent in your principal.

Again, using a $200,000 mortgage at 5% (per annum):

Pre-payment choices

Standard 25-year amortization

Increase mortgage payments once by 20% and increased payment maintained

Make payment of 20% ($40,000 at end of 1st year only)

Mortgage repaid in months

300

228

216

Total interest cost (over the life of the mortgage)

$148,962.99

$107,070.11

$81,239.37

Interest saved vs. standard 25-year amortization

N/A

$41,892.88

$65,236.20

Mortgage options can be overwhelming, but if you figure out the level of risk, commitment, and budget you're comfortable with, it should narrow your decision. By exploring—and understanding—these options before you sign on the dotted line, you'll end up with a home that will make your whole brain happy.